The Goods and Services Tax (GST) revolutionised India’s indirect tax structure by unifying multiple taxes into a single framework. Under the standard GST system, the supplier of goods or services is responsible for collecting and remitting the tax to the Government. However, in certain cases, this tax liability is shifted to the recipient of goods or services under a unique provision known as the Reverse Charge Mechanism (RCM).
RCM plays a pivotal role in ensuring tax compliance, particularly in sectors where tax evasion is prevalent. Whether you are a business owner, supplier, or service recipient, understanding how RCM works is crucial for compliance and avoiding hefty penalties. Let’s explore the concept in depth, covering its legal provisions, applicability, compliance requirements, and business implications.
Understanding Reverse Charge Mechanism (RCM) Under GST
Under normal GST rules, suppliers collect tax from buyers and deposit it with the Government. However, under RCM, the liability to pay GST shifts from the supplier to the recipient of goods or services.
Why Was RCM Introduced?
- Curb Tax Evasion – In some sectors, small or unregistered vendors might escape taxation. RCM ensures tax collection from the recipient instead.
- Improve Tax Compliance – Large businesses dealing with unregistered suppliers can ensure GST is paid, keeping tax evasion in check.
- Widen the Tax Base – This mechanism ensures that even transactions involving unregistered dealers come under GST purview.
Legal Provisions Governing RCM Under GST
The Central Goods and Services Tax (CGST) Act, 2017 defines RCM under Section 9(3) and Section 9(4):
- Section 9(3): The government has notified specific goods and services where the recipient is liable to pay tax under RCM.
- Section 9(4): RCM applies in cases where a registered person procures goods or services from an unregistered supplier, but this provision is currently applicable only for specific categories of goods or services as notified by the government. The blanket application of RCM on all purchases from unregistered suppliers, which existed in 2017, has been withdrawn since 2018.
- IGST Act, 2017: Similar provisions exist for inter-state transactions under Section 5(3) and Section 5(4).
These provisions ensure accountability and compliance in transactions where the usual tax collection mechanism is impractical.
When Does Reverse Charge Apply?
1. RCM on Notified Goods and Services (Section 9(3))
Certain categories of goods and services are subject to RCM, as per government notifications. Some examples include:
Notified Goods under RCM:
- Cashew nuts (not shelled/peeled) – Payable by the registered recipient.
- Tobacco leaves – Tax liability falls on the buyer.
- Raw cotton – Tax is paid by the recipient if procured from an agriculturist.
- Silk yarn – Tax payable by the recipient if procured from an agriculturist.
- Lottery tickets – The distributor bears GST liability.
Notified Services under RCM:
- Legal services by an advocate – The recipient (business entity) pays GST.
- Services by a government or local authority – Businesses receiving services such as renting of immovable property are liable to pay GST.
- Services provided by a director to a company – The company pays GST.
- Import of services – The recipient in India must pay GST under RCM.
- Sponsorship services – Tax payable by the recipient, usually a body corporate or partnership firm.
- Services supplied by a recovery agent to a banking company, financial institution or NBFC.
2. RCM on Supplies from Unregistered Persons (Section 9(4))
If a registered person purchases taxable goods or services from an unregistered supplier, they are required to pay GST under RCM only if such goods or services fall under categories specifically notified by the Government. The blanket application of RCM on all purchases from unregistered suppliers was withdrawn from 1 February 2019.
3. Import of Services and Applicability of RCM
When a person or business in India receives services from a foreign entity, RCM applies, ensuring that foreign service providers do not escape taxation. Examples include:
- Software development services from a foreign vendor.
- Consultancy services from international firms.
- Advertising services from Google, Facebook, or other overseas platforms.
Who Is Liable to Pay GST Under RCM?
Under RCM, the recipient of goods/services is liable for paying GST instead of the supplier. This means:
- The recipient must calculate and deposit the applicable GST.
- The recipient must issue a self-invoice since the supplier is unregistered or exempt from issuing a tax invoice.
- GST must be paid in cash (ITC cannot be used for payment under RCM).
GST Compliance and Procedural Aspects Under RCM
1. GST Registration Requirements
Businesses dealing with RCM transactions must register under GST, even if their turnover is below the exemption threshold of ₹40 lakhs (₹20 lakhs for service providers and ₹10 lakhs for specific states).
2. Tax Invoice and Documentation
- The recipient must issue a self-invoice.
- Maintain payment vouchers for RCM transactions.
- Maintain proper record-keeping for audit compliance.
3. Time of Supply Rules
Determining the time of supply is critical as it dictates when GST liability arises. Under RCM:
For goods, tax liability arises at the earliest of:
- Date of receipt of goods.
- Date of payment to the supplier.
- 30 days from the invoice date.
For services, tax liability arises at the earliest of:
- Date of payment.
- 60 days from the invoice date.
4. Input Tax Credit (ITC) on RCM Payments
While RCM tax must be paid in cash, businesses can claim ITC on the amount paid, subject to compliance with ITC rules.
Impact of Reverse Charge Mechanism on Businesses
1. Increased Compliance Burden
RCM requires businesses to maintain detailed records, self-invoice transactions, and ensure timely tax payments, increasing administrative costs.
2. Cash Flow Challenges
Since RCM tax payments cannot be adjusted through ITC and must be paid in cash first, businesses may face working capital constraints.
3. Increased Tax Awareness and Discipline
On the positive side, RCM promotes transparency and prevents tax evasion, ensuring a more robust tax collection system.
4. Impact on Small and Unregistered Suppliers
Businesses may avoid dealing with unregistered suppliers to bypass RCM obligations, indirectly pressuring small vendors to register under GST.
The Bottomline:
The Reverse Charge Mechanism (RCM) under GST serves as a crucial tool in ensuring tax compliance, plugging loopholes, and widening the tax base in India. While it increases compliance responsibilities for businesses, it also promotes transparency in tax collection. Understanding RCM is essential for businesses to avoid penalties and ensure smooth tax operations.
Whether you are a large corporation or an MSME, staying updated with GST provisions related to RCM can help you navigate the complexities of taxation efficiently. By implementing proper accounting measures and seeking professional advice when needed, businesses can comply with RCM requirements seamlessly and optimise their tax liability management.
